C K Y M OUN R O TAIN R-PACE: A GAME-CHANGER FOR …

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R-PACE: A GAME-CHANGER FOR NET-ZERO ENERGY HOMES

INSIGHT BRIEF

SEPTEMBER 2017

IIIIIIIII HIGHLIGHTS

Radhika Lalit New York, NY

rlalit@

Alisa Petersen Boulder, CO

apetersen@

? Residential property assessed clean energy (R-PACE) financing is a game-changing

financing mechanism that can help states deliver high-performance, net-zero energy (NZE) homes at no additional up-front cost.

? With a potential incremental market opportunity of over $33 billion by 2037, NZE

residences offer favorable outcomes to homeowners and real estate developers, while also benefitting the economy and the environment.

? Leading states and cities have an opportunity to invest in scaling NZE development by

enabling R-PACE for new construction.

IIIIIIIII INTRODUCTION

The U.S. residential real estate market is booming, with new home sales steadily rising over the last few years. In March 2017, over 621,000 new single-family homes were sold (see figure 1) at a median sales price of $345,800. Imagine if most of these new home developments were net-zero energy (NZE),i not only providing the homeowner net monthly energy savings but also delivering superior performance, better comfort, and grid resilience. Figure 1: Sale of New Homes in the U.S. (Seasonally Adjusted)

800

600

400

200 Houses Sold

0 May 12

May 13

May 14

May 15

Source: U.S. Census Bureau, HUD, June 23, 2017

May 16

May 17

i For the purpose of this insight brief, we define net-zero energy (NZE) homes as single-family homes with one to four units that are sustainably designed, highly energy-efficient buildings, which produce or procure enough zero-carbon renewable energy to offset their annual fossil fuel energy consumption

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Now suppose residents in your state could afford these high-performance NZE homes at no additional up-front cost using an innovative financing tool that would annually save them more money than they pay out toward the financing. Rocky Mountain Institute's (RMI's) research findings confirm that this dream scenario can be made a reality through a special application of residential property assessed clean energy (R-PACE) financing--a gamechanging financing mechanism that has already financed energy efficiency retrofits in over 158,000 homes in California, Florida, and Missouri.

This insight brief demonstrates the business case of using R-PACE for financing the rapid development of NZE new construction in states and cities across the U.S. We are working toward a future where R-PACE can enable U.S. homes to be more resilient, affordable, innovative, efficient, and high-performing and at the same time cost less than an average home.ii With a potential incremental market opportunity of over $33 billion by 2037,iii NZE residences promise a future that is propitious not only for homeowners and real estate developers but also for the U.S. economy and planet as a whole.

IIIIIIIII WHY FOCUS EFFORTS ON SCALING NZE HOMES?

NZE homes are going to be the next big frontier for innovation and competition in the residential real estate market. While mainstream real estate players are still playing catch-up, corporations like Tesla and Toyota are looking to disrupt the market with ideas that will enable our future homes to be smarter, more connected, and grid resilient. Competition in the sector is only going to rise with the pace of technological advances, and it is likely that big technology organizations will make a play for the sector in the near future. There are four important reasons why leading states and cities should invest in development of NZE homes:

1. CONSUMERS INCREASINGLY DEMAND HIGH-PERFORMING NZE HOMES:

Consumers are driving the demand for energy-efficient NZE homes and are increasingly looking for superior energy performance along with comfort, safety, accessibility, and affordability in their future homes. The 2016 National Association of Housing Builders (NAHB) survey reaffirms that energy-saving features in a newly constructed home are top of mind for buyers, who are willing to spend, on average, an additional $10,732 on the up-front price of a home to save on utility costs. This demand is driven primarily by Millennials, who make up the largest share (32 percent) and fastest growing group of homebuyers, according to a recent generational trends report by the National Association of REALTORS? (NAR). While older generations sought out homes with luxury amenities and rooms with one specific purpose, younger buyers are seeking affordable and high-performing homes. Unsurprisingly, a recent study from NAR found that 9?10 percent of millennials cite green/energy-efficiency as the main reason for buying a particular home. With consumers driving the demand, NZE home development will only continue. Presently, there are over 6,000 zero-energy and zero-energy-ready homes and apartments in North America, a 103 percent increase nationally over the past two years, signalling a transformative change in consumer needs and market paradigms.

ii This conclusion is based on RMI's business case analysis of six key states in the U.S. The details of this analysis are discussed in the Appendix. iii Market opportunity estimate assumptions: New home sales in the United States averaged 650,950 from 1963 until 2017. Median sales price of new homes in 2017 was $345,000.

Sales price increased by 4.6% between 2012--2017. Therefore, assuming a nominal increase in sales price of 4.6% compounded annually over the next 20 years (life of typical equipment). We are also assuming the average incremental cost for building an NZE home to be constant at 10% and that NZE homes will make up 60% of new home sales after 20 years.

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2. NZE HOMES MAKE BUSINESS SENSE AND HAVE SIGNIFICANT MARKET POTENTIAL:

Investment in construction of new residential buildings contributes between 3 and 5 percent of GDP. The business case and market potential for NZE new construction is compelling. A case in point is Efficiency Vermont's Net Zero Feasibility Study, which demonstrates that NZE homes make for the best investment before rebates or incentives, both in year one and over a 30-year loan period. In terms of market potential, Pike Research estimates that by 2035, $1.3 trillion will be spent on zero-energy homes and buildings worldwide. RMI's research confirms that NZE homes present an incremental market opportunity of $33 billion for the U.S. real estate industry by 2037.iv These are compelling statistics that will eventually translate into more jobs for the U.S. economy overall.

3. NZE DEVELOPMENT CAN HELP FULFILL AMBITIOUS STATE OR CITY CARBON REDUCTION GOALS:

Fifty-eight percent of U.S. states have implemented ambitious renewable energy portfolio requirements in the form of renewable portfolio standards (RPS) or alternative energy portfolio standards (AEPS) and/or instituted state-wide climate and sustainability goals. Since buildings consume 40 percent of U.S. energy consumption and account for over 39 percent of U.S. CO2 emissions, these states and cities are unlikely to meet their goals without making concerted efforts to drive building energy efficiency. While the commercial residential sector is making steady progress, the residential sector is still catching up. Several cities and states recognize this challenge and are already mandating stricter building codes and energy disclosure requirements that support NZE home development to further their climate commitments through a market-ready approach. For instance, California's building codes are expected to require all new home construction to be "zero energy ready" by 2020. At the same time, the state of Washington designed its state energy building codes to encourage zero-energy home development by 2031. Cities like Montpelier, Vermont, are also driving ambitious projects. Net Zero Montpelier aims to transform Montpelier's energy system in an effort to make it the nation's first state capital where all the energy will be produced or offset by renewable energy sources.

It is also important to note that the aggressive carbon-reduction goals set by states such as Colorado, Connecticut, Vermont, Massachusetts, and others are likely to be achieved only when the majority of their new building stock is NZE. The policies implemented by these cities and states will have a profound impact on the growth of NZE home development and are likely to pave the way for others to adopt similar strategies.

4. AGING BUILDING STOCK AND COMPELLING NEW CONSTRUCTION-PROJECT ECONOMICS PRESENT AN OPPORTUNITY FOR NEW NZE DEVELOPMENT:

According to the 2015 American Community Survey, the median age of the U.S. building stock is 37 years. In RMI's experience, the incremental cost of efficiency measures for new construction is usually one-third of the estimated cost in a typical energy retrofit scenario, which by its nature necessitates the replacement of existing functioning systems in order to achieve the deep

iv Refer to calculations in the section above.

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efficiency gains necessary to achieve NZE performance. Therefore, the more immediate, costeffective, and straightforward approach to building smarter cities for the future is to scale the adoption of NZE new construction first, closely followed by planning major construction renovations to aging existing buildings where energy retrofits have compelling project economics. Encouraging and incentivizing all new construction to be NZE or NZE-ready is not just an effective policy tool but an imperative.

IIIIIIIII MARKET BARRIERS FOR SCALING NZE HOME CONSTRUCTION

There are several market, policy, and implementation barriers to scaling NZE residential development in the U.S. However, for the purpose of this insight brief, we will be addressing the three most prominent market barriers affecting the growth of this sector: incremental up-front capital costs, valuation uncertainty regarding energy performance, and builder/homeowner split incentives.

? Large up-front capital costs for both the builder and homebuyer: Depending on state policies, climatic conditions, and construction costs, constructing an NZE home could cost more up front than constructing an average home. RMI's research, discussed in the Appendix, suggests that the incremental up-front cost to construct an NZE home could vary anywhere from 5.2 percent to 11.5 percent (without incentives and tax rebates) of the total construction cost across California, Missouri, Florida, New York, Colorado, and Georgia, which collectively comprise almost one-third of the single-family housing market. This up-front capital cost is one of the major deterrents for builders and developers looking to invest in NZE real estate development. At the same time, even if the builders employed their equity to finance this incremental up-front cost, this cost would ultimately have to be transferred onto the homebuyer for whom this is a substantial financial burden and barrier at point of sale.

? Home valuations do not reflect NZE performance: Most NZE homes demonstrate superior energy performance over average homes while accruing substantial energy savings to the homeowner year-on-year. These energy cost savings should ideally translate to an increase in value of NZE homes. However, it is less clear how energy performance of NZE homes is presently valued by appraisers, lenders, or even homebuyers. This valuation uncertainty is a major market failure and one of the reasons for the latent consumer demand for NZE homes.

? Builder/homebuyer cost-benefit split incentive and transaction uncertainty: According to NAHB's analysis of the Census Bureau's Survey of Construction, in 2015 more than 73 percent of the homes in the U.S. were built by builders for sale while only 22 percent of the homes were custom built by homeowners. Builders, who control almost three-fourths of this market, have been unwilling to invest up-front equity for installing energy-efficient appliances or ensuring renewable energy integration during the home construction process since they do not directly benefit from the operational cost savings and have no incentive to maximize them. Moreover, even if builders did invest in these improvements, they don't have sufficient certainty that homebuyers will be willing to pay more up front for long-term savings at the time of sale to justify the additional project costs. The misaligned builder incentives and weak market signals have also been a significant barrier to NZE new construction.

ROCKY MOUNTAIN INSTITUTE * WWW. * BASALT, CO * BOULDER, CO * NEW YORK, NY * WASHINGTON, D.C. * BEIJING, CHINA

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IIIIIIIII HOW RESIDENTIAL PACE CAN SCALE THE NZE HOME MARKET

Residential PACE (R-PACE) is an innovative financing mechanism used to finance energy efficiency, renewable energy, resilience, and water-saving home improvements. R-PACE assessment is typically attached to a property's tax bill secured by the same type of lien against the property as tax bills and is repaid through property taxes. It is unique in that it is transferable upon sale of the property because the financing is tied to the property rather than the property owner. Overall, R-PACE has been extremely effective in tackling a significant market failure by increasing American households' access to financial resources so that they can realize the benefits of cost-saving and resilient high-performance homes. R-PACE has successfully financed over 158,000 retrofits in three states since 2008, which demonstrates its market acceptability, scalability, and potential as a transformational market financing tool. It is worth noting that R-PACE has seen unprecedented growth in California, which has been largely driven by enabling state legislation. This growth has now started to spread across other states like Florida and Missouri.

Presently, R-PACE has been primarily used for home improvement retrofits, and new construction is not eligible as an option to most builders or developers within the existing state-enabled programs of California, Florida, and Missouri.v

RMI strongly believes that R-PACE has the potential to resolve the most prominent market barriers to scale NZE new construction development for the following reasons:

1. R-PACE PROVIDES INCREMENTAL UP-FRONT CAPITAL INVESTMENT FOR NZE HOME CONSTRUCTION: R-PACE can solve a major market failure by providing both homeowners and builders/developers the requisite up-front capital to finance the measures for NZE home construction. This mechanism is especially well suited to new construction since it allows the incremental costs to be repaid over a long period of time as the savings are realized. At the same time, this assessment is attached to the property rather than the individual, so in case of a sale, the new property owner pays the "amortized" costs as he or she enjoys the savings. RMI's analysis, summarized in the Appendix, confirms that while the average incremental up-front cost for constructing an NZE single-family home was $24,811 (excluding the federal investment tax credit and other state-specific incentives), it is likely to vary between 5.2 percent and 11.5 percent of the construction cost depending on the state (see figure 2 below). The results of our analysis emphasize the need for policy drivers to support financing instruments like R-PACE to help finance the incremental capital construction costs to drive the growth of NZE development.

V In California, under the HERO program, new construction is not eligible, unless ownership has been transferred from the developer to the property owner.

ROCKY MOUNTAIN INSTITUTE * WWW. * BASALT, CO * BOULDER, CO * NEW YORK, NY * WASHINGTON, D.C. * BEIJING, CHINA

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